Green Banking in Bangladesh

DEFINITION OF CREDIT RISK GRADING (CRG) * The Credit Risk Grading (CRG) is a collective definition based on the pre-specified scale and reflects the underlying credit-risk for a given exposure. * A Credit Risk Grading deploys a number/ alphabet/ symbol as a primary summary indicator of risks associated with a credit exposure. * Credit Risk Grading is the basic module for developing a Credit Risk Management system. FUNCTIONS OF CREDIT RISK GRADING Its managed credit risk grading systems promote bank safety and soundness by facilitating informed decision-making.

Grading systems measure credit risk and differentiate individual credits and groups of credits by the risk they pose. This allows bank management and examiners to monitor changes and trends in risk levels. The process also allows bank management to manage risk to optimize returns. How to Compute CRG Risk| Key Parameters| Grade| Financial Risk| Leverage, Liquidity, Profitability, Coverage ratio| 50%| Business/Industry | Size, Age of Business, Business Outlook, Industry Growth, Competition, & Barrier to business. 18%| Management| Experience, Succession & Team Work| 12%| Security| Security, Collateral Coverage & Support | 10%| Relationship| Account Conduct, Utilization of Limit, Compliance & Personal Deposit. | 10%| Total| 100%| CRG METHODOLOGY & MODEL When a credit applicant comes to the bank the credit department of the bank calculates the performance ratio of the proposed project. Also calculate the IRR, NPV, Payback period of the project. Credit Risk Grading must be measure by the bank before and after loan sanction & loan collection steps.

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A sample is provided to understand the methodology of CRG. Companies named Butterfly Marketing Ltd. which leverage ratio calculate by the bank 4. 72, Liquidity ratio 1. 01, and Profitability ratio 8. 35 Coverage ratio 2. 35. After scoring it’s found that the company’s total score stand by 65. According to the score sheet it’s categorized as a marginal/watch-list. The procedure has been focused in the next pages. The credit department provides loan to the company by keep regular watch-list its financial position & repayment trend. In that way bank decide which project/which party is flexible for sanction loan.

Credit Assessment & Risk Grading Credit Assessment A thorough credit and risk assessment should be conducted prior to the granting of loans, and at least annually thereafter for all facilities. The results of this assessment should be presented in a Credit Application that originates from the relationship manager/account officer (“RM”), and is approved by Credit Risk Management (CRM). The RM should be the owner of the customer relationship, and must be held responsible to ensure the accuracy of the entire credit application submitted for approval.

RMs must be familiar with the bank’s Lending Guidelines and should conduct due diligence on new borrowers, principals, and guarantors. It is essential that RMs know their customers and conduct due diligence on new borrowers, principals, and guarantors to ensure such parties are in fact who they represent themselves to be. All banks should have established Know Your Customer (KYC) and Money Laundering guidelines which should be adhered to at all times. Credit Applications should summaries the results of the RMs risk assessment and include, as a minimum, the following details: * Amount and type of loan(s) proposed. Purpose of loans. * Loan Structure (Tenor, Covenants, Repayment Schedule, Interest) * Security Arrangements In addition, the following risk areas should be addressed: * Borrower Analysis. The majority shareholders, management team and group or affiliate companies should be assessed. Any issues regarding lack of management depth, complicated ownership structures or inter-group transactions should be addressed, and risks mitigated. * Industry Analysis. The key risk factors of the borrower’s industry should be assessed.

Any issues regarding the borrower’s position in the industry, overall industry concerns or competitive forces should be addressed and the strengths and weaknesses of the borrower relative to its competition should be identified. * Supplier/Buyer Analysis. Any customer or supplier concentration should be addressed, as these could have a significant impact on the future viability of the borrower. * Historical Financial Analysis. An analysis of a minimum of 3 years historical financial statements of the borrower should be presented. Where reliance is placed on a corporate guarantor, guarantor financial statements should also be analysed.

The analysis should address the quality and sustainability of earnings, cash flow and the strength of the borrower’s balance sheet. Specifically, cash flow, leverage and profitability must be analyzed. * Projected Financial Performance. Where term facilities (tenor > 1 year) are being proposed, a projection of the borrower’s future financial performance should be provided, indicating an analysis of the sufficiency of cash flow to service debt repayments. Loans should not be granted if projected cash flow is insufficient to repay debts. * Account Conduct.

For existing borrowers, the historic performance in meeting repayment obligations (trade payments, cheques, interest and principal payments, etc) should be assessed. * Adherence to Lending Guidelines. Credit Applications should clearly state whether or not the proposed application is in compliance with the bank’s Lending Guidelines. The Bank’s Head of Credit or Managing Director/CEO should approve Credit Applications that do not adhere to the bank’s Lending Guidelines. * Mitigating Factors. Mitigating factors for risks identified in the credit assessment should be identified.

Possible risks include, but are not limited to: margin sustainability and/or volatility, high debt load (leverage/gearing), overstocking or debtor issues; rapid growth, acquisition or expansion; new business line/product expansion; management changes or succession issues; customer or supplier concentrations; and lack of transparency or industry issues. * Loan Structure. The amounts and tenors of financing proposed should be justified based on the projected repayment ability and loan purpose. Excessive tenor or amount relative to business needs increases the risk of fund diversion and may adversely impact the borrower’s repayment ability. Security. A current valuation of collateral should be obtained and the quality and priority of security being proposed should be assessed. Loans should not be granted based solely on security. Adequacy and the extent of the insurance coverage should be assessed. * Name Lending. Credit proposals should not be unduly influenced by an over reliance on the sponsoring principal’s reputation, reported independent means, or their perceived willingness to inject funds into various business enterprises in case of need. These situations should be discouraged and treated with great caution.

Rather, credit proposals and the granting of loans should be based on sound fundamentals, supported by a thorough financial and risk analysis. Risk Grading All Banks should adopt a credit risk grading system. The system should define the risk profile of borrower’s to ensure that account management, structure and pricing are commensurate with the risk involved. Risk grading is a key measurement of a Bank’s asset quality, and as such, it is essential that grading is a robust process. All facilities should be assigned a risk grade.

Where deterioration in risk is noted, the Risk Grade assigned to a borrower and its facilities should be immediately changed. Borrower Risk Grades should be clearly stated on Credit Applications. The following Risk Grade Matrix is provided as an example. The more conservative risk grade (higher) should be applied if there is a difference between the personal judgment and the Risk Grade Scorecard results. It is recognized that the banks may have more or less Risk Grades; however, monitoring standards and account management must be appropriate given the assigned Risk Grade:

Risk Rating| Grade| Definition| Superior – Low Risk| 1| Facilities are fully secured by cash deposits, government bonds or a counter guarantee from a top tier international bank. All security documentation should be in place. | Good – Satisfactory Risk| 2| The repayment capacity of the borrower is strong. The borrower should have excellent liquidity and low leverage. The company should demonstrate consistently strong earnings and cash flow and have an unblemished track record. All security documentation should be in place. Aggregate Score of 95 or greater based on the Risk Grade Scorecard. Acceptable – Fair Risk| 3| Adequate financial condition though may not be able to sustain any major or continued setbacks. These borrowers are not as strong as Grade 2 borrowers, but should still demonstrate consistent earnings, cash flow and have a good track record. A borrower should not be graded better than 3 if realistic audited financial statements are not received. These assets would normally be secured by acceptable collateral (1st charge over stocks / debtors / equipment / property). Borrowers should have adequate liquidity, cash flow and earnings. An Aggregate Score of 75-94 based on the Risk Grade Scorecard. Marginal – Watch list | 4| Grade 4 assets warrant greater attention due to conditions affecting the borrower, the industry or the economic environment. These borrowers have an above average risk due to strained liquidity, higher than normal leverage, thin cash flow and/or inconsistent earnings. Facilities should be downgraded to 4 if the borrower incurs a loss, loan payments routinely fall past due, account conduct is poor, or other untoward factors are present. An Aggregate Score of 65-74 based on the Risk Grade Scorecard. | Special Mention | 5| Grade 5 assets have potential weaknesses that deserve management’s close attention.

If left uncorrected, these weaknesses may result in a deterioration of the repayment prospects of the borrower. Facilities should be downgraded to 5 if sustained deterioration in financial condition is noted (consecutive losses, negative net worth, excessive leverage), if loan payments remain past due for 30-60 days, or if a significant petition or claim is lodged against the borrower. Full repayment of facilities is still expected and interest can still be taken into profits. An Aggregate Score of 55-64 based on the Risk Grade Scorecard. Substandard| 6| Financial condition is weak and capacity or inclination to repay is in doubt. These weaknesses jeopardize the full settlement of loans. Loans should be downgraded to 6 if loan payments remain past due for 60-90 days, if the customer intends to create a lender group for debt restructuring purposes, the operation has ceased trading or any indication suggesting the winding up or closure of the borrower is discovered. Not yet considered non-performing as the correction of the deficiencies may result in an improved condition, and interest can still be taken into profits.

An Aggregate Score of 45-54 based on the Risk Grade Scorecard. | Doubtful and Bad(non-performing)| 7| Full repayment of principal and interest is unlikely and the possibility of loss is extremely high. However, due to specifically identifiable pending factors, such as litigation, liquidation procedures or capital injection, the asset is not yet classified as Loss. Assets should be downgraded to 7 if loan payments remain past due in excess of 90 days, and interest income should be taken into suspense (non-accrual). Loan loss provisions must be raised against the estimated unrealisable amount of all facilities.

The adequacy of provisions must be reviewed at least quarterly on all non-performing loans, and the bank should pursue legal options to enforce security to obtain repayment or negotiate an appropriate loan rescheduling. In all cases, the requirements of Bangladesh Bank in CIB reporting, loan rescheduling and provisioning must be followed. An Aggregate Score of 35-44 based on the Risk Grade Scorecard| Loss(non-performing)| 8| Assets graded 8 are long outstanding with no progress in obtaining repayment (in excess of 180 days past due) or in the late stages of wind up/liquidation.

The prospect of recovery is poor and legal options have been pursued. The proceeds expected from the liquidation or realization of security may be awaited. The continuance of the loan as a bankable asset is not warranted, and the anticipated loss should have been provided for. This classification reflects that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. Bangladesh Bank guidelines for timely write off of bad loans must be adhered to.

An Aggregate Score of 35 or less based on the Risk Grade Scorecard| At least top twenty five clients/obligors of the Bank may preferably be rated by an outside credit rating agency. Historical Background of BASIC Bank Ltd. : The BASIC Bank Limited (Bangladesh Small Industries and Commerce Bank Limited) establishes as a banking company under the companies Act 1913 launched its operation in 1989. It was incorporated under the Act on the 2nd of August, 1988. The Bank started its operation from the 21st of January, 1989 . It is governed by the Banking Companies Act 1913.

The Bank was established as the policy makers of the country felt the urgency for a bank in the private sector for financing Small Scale Industries (SSIs). At the outset, the Bank started as a joint venture enterprise of the BCC Foundation with 70 percent shares and the Government of Bangladesh (GOB) with the remaining 30 percent shares. The BCCI, the Government of Bangladesh took over 100 percent ownership of BASIC on 4th June 1992. Thus there is state-owned. However, the Bank is not nationalized; it operates like a private bank as before. Basic Bank is unique in its objectives.

It is blend of development and commercial banks. The Memorandum and Articles of Association of the Bank stipulate that 50 percent of loan able funds shall be invested in small and cottage industries sector. Steady growth in client base and their high retention rate since Bank’s inceptions testify to the immense confidence they repose on its services. Diversified products both liability and assets sides particularly a wide range of lending products related to development of small industries and micro enterprises, and commercial and training activities attract entrepreneurs from varied economic fields.

Along with promotion of products special importance is given to individual clients through providing personalized services. In fact individuals matter in this Bank. This motto has been followed for development of clientele as well as human resources of the Bank. Coping with the competitive and rapidly changing financial market of the country, BASIC Bank Limited maintains close connection with its clients, the regulatory, the shareholders (Government of Bangladesh), other banks and financial institutions. Basic Bank Limited Offers: Term loans to industries especially to small-scale enterprise. * Full-fledged commercial banking services including collection of deposit, short-term trade finance, working capital finance in processing and manufacturing units and financing and facilitating international trade. * Technical support to Small Scale Industries (SSIs) I order to enable them to run their enterprise successfully. * Micro-credit to the urban poor linkage with Non-Government Organizations (NGOs) with view facilitating their access to the formal financial market for mobilization of funds. In order to perform the above tasks, BASIC works closely with the clients, the regularly authorities the shareholders Government of Bangladesh (GOB), banks and other financial institution. Different Types of credit facilities of BASIC Bank Ltd. : There are many private commercial Banks in our country that offer different nature’s credit facility. Bank credit is a catalyst for bringing about economic development.

The bank always search for new avenues for investment and develop new products to suit such needs and obviously try to employ funds for profitable purpose in various field with special emphasis on small and medium scale industries for promoting and aiding SSI and MSI sector. Basically the bank offer following credit facilities: Types of Credit Facilities A. Project Loan Term Loan (Short term Medium, Long) Working Capital ( SOD, Cash credit, Loan Genaral) Funded Non-Funded Letter of Credit C. Micro Credit Letter of Grantee Bank Gurantee B. Foreign Trade Credit Import finance ( LTR. LIM. PAD) Export Finance: Pre-shipment(L/C, PC)

Post-Shipment(LBP,FBP) Diagram of Credit facilities Credit Information of BASIC Bank Ltd. (2009) for Credit Risk Grading: All amounts are in Crore (TK) Credit Risk Exposure of BASIC Bank Ltd. : Calculating CRG of Individual Credit: BASIC Bank Ltd. provides many types of credit. For calculating CRG for specific loans and advances we need the following data: 1. Balance Sheet of that firm 2. Income Statement of that firm 3. Their leverage condition 4. Sales Information 5. Liquidity Information 6. Profitability Information 7. Their management Information 8. Management Experience 9. Age of Business 10. Industry Information

Calculating the Ratios for CRG: By using the above information we need to calculate the following ratios: 1. Leverage Ratio: Debt to Equity Ratio = LiabilitiesNet Worth 2. Liquidity Ratio: Current Ratio = Current AssetsCurrent Liabilities 3. Profitability Ratio: Profit Margin Ratio = Net Income Sales 4. Coverage Ratio: Interest Coverage Ratio = EBITInterest on Debt After calculating the required ratios we use it CRG scoring Sheet as following way: At first we calculate the above ratios from the Balance sheet and Income Statement of the assessing company or the company who submit loan proposal to the BASIC Bank Ltd. nd then we use it the column of Actual Parameter. Here one of the BASIC Bank’s clients’ CRG Scoring Sheet is given. Arrive at the Credit Risk Grading based on total score obtained: Number | Risk Grading| Short Name | Score| 1| Superior| SUP| * 85 – 100 * Credit facilities fully cash covered (100%) or near cash. * Government guarantee * International Bank guarantee | 2| Good| GD| 75 – 84| 3| Acceptable| ACCPT| 65 – 74| 4| Marginal/Watchlist| MG/WL| 55 – 64| 5| Special Mention| SM| 45 – 54| 6| Sub standard| SS| 35 – 44| 7| Doubtful| DF| 25 – 34| 8| Bad & Loss | BL | < 25|

As our score is 65 so we can say that the loan is in “Acceptable” grade. CREDIT RISK GRADING REVIEW Credit Risk Grading for each obligor should be assigned at the inception of lending and should be periodically updated. Frequencies of the review of the credit risk grading are mentioned below: Number| Risk Grading| Short| Review frequency (at least) | 1| Superior| SUP| Annually | 2| Good| GD| Annually| 3| Acceptable| ACCPT| Annually | 4| Marginal/Watchlist| MG/WL| Half yearly | 5| Special Mention| SM| Quarterly | 6| Sub standard| SS| Quarterly| 7| Doubtful| DF| Quarterly| 8| Bad & Loss | BL | Quarterly|

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